Numeraire: What it is, History, How it Works

What Is Numeraire?

Numeraire is an economic term of French origin, which acts as a benchmark in comparing the value of similar products or financial instruments. The word numeraire translates as "money," "coinage," or "face value."

Understanding Numeraire

Numeraire is an economic term that represents a unit in which prices are measured. A numeraire is usually applied to a single good, which becomes the base value for the entire index or market. Having a numeraire, or base value, allows for the comparison of the value of goods against one another. In essence, the numeraire acts as a set standard of value across an exchange.

An example of a numeraire arises when we look at how currencies were valued under the Bretton Woods system during the mid-20th century. The U.S. dollar (USD) was priced at one-thirty-fifth (1/35^th) the price of an ounce of gold. All other currencies were then priced as either a multiple or a fraction of the dollar. In this situation, the USD acted as the de facto benchmark, or numeraire, because it was fixed to the price of gold.

Today, the U.S. dollar remains the numeraire for most commodity prices. Denominating commodity prices in U.S. dollars standardizes the price as the USD is the most-traded and liquid currency in the world. For example, companies that engage in oil transactions can easily convert payments or receipts in a timely manner since the price of oil is denominated in USD. 

Also, by setting oil prices in USD, it allows a country to compare the value of oil prices in its own currency. For example, if a country that is a net importer of oil has a currency that is weakening against the U.S. dollar, it will be paying more for its oil (in local currency terms) than it did in the past.